Tracing shell companies

November 04, 2019

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Few people in Pakistan gave a thought to ‘shell’ companies until April 3, 2016, when the Panama Papers took the world by storm. That is why a former regulator affirmed: “There is no regulatory framework for such companies. The Companies Act of 2017 or the Code of Corporate Governance makes no mention of such entities.”

It was a big surprise that even some well-known market gurus, analysts and regulators were totally unaware of the exact purpose of shell companies.

One person believed that such entities were created for transaction structuring or passive investments. Others thought they were akin to the single-purpose vehicles (SPV) governed under the Securitisation Rules of 1999.

But what actually are shell companies? Dr Tariq Hasan, former chairman of the Securities and Exchange Commission of Pakistan (SECP), observed: “Shell companies are formed to hide the names of real owners. They are used to evade or avoid taxes.”

He affirmed that there were “no laws, rules or regulations that gave cover to shell companies in Pakistan” and, accordingly, he concluded that there were no such companies in the country.

Some definitions of shell companies affirm that such companies exist only on paper and have no offices or employees. They may have bank accounts but no significant business activity. There is no public record of the owner of the company. Individuals protect their assets by registering them in the name of shell companies.

“It is financial engineering to avoid paying taxes,” the International Monetary Fund (IMF) says in a new study, which claims that $15 trillion is held in shell companies across the globe.

Buried deep under the high-profile cases of politicians, the Panama Papers also revealed the names of 259 Pakistanis who are the beneficial owners of shell companies

A retired corporate head gave a comprehensive list of tax havens that are fertile lands for setting up shell companies: Andorra, The Bahamas, Belize, Bermuda, The British Virgin Islands, The Cayman Islands, The Channel Island, The Cook Islands, Hong Kong, The Isle of Man, Lichtenstein, Monaco, Panama and Saint Kitts and Nevis and Mauritius.

The globetrotting businessman claimed that a member of the current government’s economic team had in the past helped seths incorporate dozens of companies in Mauritius.

Buried deep under the high-profile cases of politicians, the Panama Papers also revealed the names of 259 Pakistanis, mainly high-net-worth individuals, who are the beneficial owners of shell companies.

In the case of Jahangir Tareen’s $7m Hyde House in the United Kingdom, it was revealed to the Supreme Court that the 38-page trust deed was signed in Geneva, Switzerland, and was facilitated by HSBC Guyerzeller Trust. Financial Times mentioned in an article that HSBC and its subsidiaries alone account for more than 2,300 of the 15,600 shell companies created by the Panama-based firm over four decades.

Do shell companies exist in Pakistan? A former banker said: “I believe they do exist but definitely not on the scale of Panama, Cayman Islands etc.” He added that perhaps a few of them exist for money laundering purposes.

Besides tax avoidance, a major reason for setting up a shell company is the concealment of the beneficial owner. “The current regulations require financial institutions in Pakistan to identify the ultimate beneficial owner (UBO) of the institution investing with them,” said a corporate lawyer.

He also ruled out any mentionable existence of shell companies in Pakistan for no one would want to grab the spotlight by setting up such an entity. Besides, high taxation sets the country apart from offshore tax havens.

A shell company cannot be listed on the Pakistan Stock Exchange (PSX), said a knowledgeable person. “That is a completely mutually exclusive event. If it gets listed, it will not remain a shell company,” he said.

It was a big surprise that even market gurus, analysts and regulators were unaware of the exact purpose of shell companies

While shell companies could be a rare phenomenon, the country’s capital market is replete with ‘inactive’ companies. At least a third of the 558 companies quoted on the stock market are inactive. It may not be difficult to pick them out from textile, sugar, cement, food and personal care, modaraba, investment banking, insurance and synthetic and rayon sectors. Such companies trading at 80-90pc discount to their par values.

A friend who invested in a textile company and has not heard from it for years narrated his ordeal, which was shocking and also had a tinge of humour. He said he located the company’s registered office set up way up in the northern mountains. The office was shut with a big rusty lock staring in the face.

So he travelled up to the site of the plant mentioned in the company’s annual report from many years ago. “There was no plant and machinery. It was a piece of flat land,” he said. On further enquiry, his heart sank as he learned that the company owners had sold the land three years ago.

The regulators have neither the resources nor the inclination to arrange any physical inspection of the existence of listed companies. But such non-existent, inactive companies continue to be quoted on the stock exchange at token values.

A former chairman of the SECP said that the matter of inactive companies was close to his heart and that he tried to bring about reforms during his tenure. He believed that it was easy to identify inactive companies by monitoring their tax returns, bank accounts and business activities. But he lamented the fact that no one was willing to work.

“Listed companies that fail to file yearly accounts, tax returns and other mandatory documents and those that do not hold annual general meetings of shareholders for two consecutive years without providing the regulator with a valid reason should be wound up,” he said.

He affirmed that it was an international best practice to get rid of inactive entities. He said the apex regulator’s offices in Islamabad were devoid of automation, which precludes the latest data compilation of registered companies.

“Every time I tried to install a modern system, I faced stiff resistance from companies’ registration officers (CROs),” he said. However, he stopped short of mentioning the reason for the CROs’ resistance.

Published in Dawn, The Business and Finance Weekly, November 4th, 2019